Federated Investors, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. The filing reports the July 1, 2018 consolidation of Hermes Fund Managers Limited. Unless stated otherwise, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $308.6 | $278.3 | $828.5 | $824.6 |
| Operating income | $81.9 | $88.7 | $242.3 | $250.7 |
| Net income attributable to Federated | $59.6 | $56.4 | $158.8 | $159.5 |
| Basic and diluted EPS | $0.59 | $0.56 | $1.57 | $1.57 |
| Cash dividends per share | $0.27 | $0.25 | $0.79 | $0.75 |
- Q3 revenue rose 10.9%, while operating income fell 7.7%; net income attributable to Federated increased 5.6%. Nine-month revenue was up 0.5%, operating income down 3.3%, and net income down 0.5% year over year.
- Operating margin was approximately 26.5% in Q3 2018 versus 31.9% in Q3 2017, and 29.3% for the first nine months of 2018 versus 30.4% in 2017.
- Q3 revenue growth primarily reflected $49.7 million of Hermes revenue. Nine-month results also included Hermes from July 1; acquisition contributions were offset by lower revenue from money-market asset mix, Topic 606 presentation changes, and a previously disclosed customer relationship change.
- Operating expenses were $226.7 million in Q3, up $37.1 million. Compensation rose with Hermes consolidation; professional fees increased partly from acquisition costs. Distribution expense declined, partly reflecting money-market asset mix and the reclassification of customer consideration under Topic 606.
- Nine-month nonoperating expenses were $27.9 million, including a $29.0 million loss on foreign-exchange forwards entered into for the Hermes purchase. The nine-month effective tax rate fell to 25.1% from 37.0%, primarily due to the Tax Act.
Cash, debt and liquidity
- Cash and cash equivalents were $116.9 million at September 30, 2018, down from $316.3 million at December 31, 2017. Long-term debt was $160.0 million, versus $170.0 million; approximate cash net of debt was $43.1 million of net debt.
- Net cash from operating activities was $86.4 million for the first nine months, down from $197.4 million. Investing activities used $163.4 million, primarily reflecting the Hermes acquisition; financing activities used $122.2 million, including dividends, share repurchases and debt payments.
- Federated reported $184.7 million of liquid assets, net of noncontrolling interests, compared with $392.6 million at year-end 2017. It had $215 million available under its revolving facility and was compliant with debt covenants. Management said existing liquidity, operating cash flow and borrowing capacity should cover present and reasonably foreseeable needs.
- Debt carried a 3.229% interest rate at quarter-end and matures under the credit agreement in June 2022. Covenant leverage was 0.4 to 1 against a maximum of 3 to 1; interest coverage was 72 to 1 against a minimum of 4 to 1.
Business changes, outlook and risks
- Period-end managed assets were $437.2 billion, up 20% year over year, primarily due to Hermes. Average managed assets increased 20% in Q3 and 12% for the nine-month period. Long-term assets had $7.3 billion of net redemptions over the nine months, before acquisition-related assets and market movements.
- Federated paid £260.7 million ($344.3 million) for control of Hermes. BT Pension Scheme retained a redeemable 29.5% interest, with put and call options exercisable after specified anniversaries; employee awards also carry fair-value put/call features. The preliminary purchase-price allocation included $161.2 million of goodwill and $271.7 million of intangible assets. The allocation may change materially. Management anticipated about $1 million in additional transaction costs in Q4.
- The acquisition-related hedge loss was recorded in Q2, and total directly attributable transaction costs were $14.5 million, of which $12.7 million had been expensed by quarter-end. Hermes contributed $49.7 million revenue and $5.7 million net income in Q3, before acquisition-related intangible amortization and noncontrolling-interest attribution.
- No numerical earnings or revenue guidance is provided. Management identifies AUM, product flows and mix, market conditions, fee waivers, and regulation as important performance drivers. It noted potential effects from U.S. money-market and liquidity rules, fiduciary proposals, Brexit, European money-market reforms, and possible financial transaction taxes. The timing and impact of regulatory changes remain uncertain.
- Money-market fund fee waivers totaled $89.3 million in Q3 and $264.9 million year to date, versus $83.8 million and $259.2 million, respectively, in the comparable 2017 periods. The company says changes in yields, investor preferences and asset levels can affect waivers, revenue and profitability.
- Management reported no indicators of goodwill impairment and no material change in disclosed market-risk exposures. It did not believe material losses from ordinary-course claims or indemnifications were reasonably possible. The purchase-price allocation remains preliminary, and Hermes internal controls were excluded from the quarter’s controls assessment; management concluded the assessed disclosure controls were effective.
- An auditor-independence matter involving an investment by an EY affiliate pension trust in a Hermes-managed fund was disclosed. EY reported that the trust sold its entire interest on August 29, 2018; management and the Audit Committee continued to support EY’s objectivity.
Investor verification points
- Review the final Hermes purchase-price allocation, acquisition-related amortization and costs, and terms and potential cash requirements of the minority-interest options and employee awards.
- Assess whether AUM growth is translating into durable organic flows and revenue, separating acquisition-related assets from market performance and net redemptions.
- Track operating expenses, operating margins, asset mix, fee waivers and the impact of Topic 606 presentation changes on period comparisons.
- Monitor cash generation and use, debt levels, available credit capacity, dividend and repurchase spending, and compliance with credit covenants.
- Follow regulatory and Brexit developments, and confirm integration of Hermes controls and resolution of the disclosed auditor-independence matter.